Pandora, the online radio company that went public today, is losing money. Yet investors are rushing in to buy Pandora stock, which is now valued at over $3 billion.
Groupon is in a similar boat. The company is also losing money, but could be valued at $20 billion when it goes public later this year.
It's relatively common for young companies to pursue growth at the expense of profit. Amazon chose to lose money for years, and now is solidly profitable.
But Pandora and Groupon may face particular challenges in turning a profit. For different reasons, both companies may struggle to scale.
Some businesses scale beautifully. Think of a software company. Once you create a piece of software, the cost of selling it to a thousand customers isn't much different than the cost of selling it to a million customers. So once your software is written, the more customers you have, the more money you make.
For Pandora, on the other hand, more listeners means higher costs. Every time someone listens to a song on Pandora, the company has to pay royalties for the song. More users means more royalty payments.
Of course, more listeners should also mean more advertising revenues. But rising ad revenue is contingent on the company being able to sell ads. And that may be a challenge. As the WSJ's Heard on the Street notes:
only about 1% of listener hours are devoted to ads, compared to traditional radio's roughly 20%. Those ads often repeat, implying advertisers aren't jumping on board fast enough.
For Groupon, signing up new subscribers may be growing both less lucrative and more expensive.
Revenue per subscriber has has fallen as the company has grown, the NYT has pointed out.
At the same time, the company is spending lots of money to lure those new subscribers.
In its IPO filing, Groupon broke out a few single-city case studies. Based on those numbers, Yipit took a close look at the numbers for Groupon's Boston business.
They found that, as the number of Groupon's Boston subscribers is rising,
- Revenue per Groupon customer is declining
- Cost to acquire those customers are increasing
- Sales costs are increasing as it needs to run smaller deals with more merchants to personalize the experience